The tobacco giant’s rock-star year that was 2016 now seems a distant memory. Into the tailspin has gone the top line at Pakistan Tobacco Limited (PSX: PAKT), as per the half-yearly financials the firm released yesterday. The firm’s 1QCY17 gross turnover had declined by 34 percent year-on-year. The latest financials show that the top line depression had gone up to 42 percent year-on-year in 2QCY17.
After amassing a record Rs10 billion in net profits in CY16, PAKT closed the half year on a depleted note. The magnitude of 1HCY17 top line slump (39% year-on-year) is a bit stunning. But the apparent reasons for the fall are hardly surprising.
The formal tobacco industry’s sales volumes (cigarette sticks) have been declining for a while. And PAKT, being the industry leader, has been the worst hit when it comes to numbers. From a high of 44 billion sticks in CY14, its cigarette sticks sales had shrunk to 36 billion in CY16 (see the illustration). One presumes a steep volumetric decline in 1HCY17 as well
Informal tobacco players are said to be eating into the formal players’ share. Illicit cigarettes are being sold cheaper even when compared to some of the most economical products of the formal sector. PAKT management has previously cited local duty-non-paid (DNP) cigarettes as the major culprit, accounting for about forty percent of cigarettes sold domestically. DNP smokes are extremely price-competitive in this low-income market. They evade exorbitant taxes/duties, undercutting legitimate players.
The government, through the FY18 budget, has announced a few administrative measures to check the proliferation of illicit cigarettes. But the scale of the illicit trade seems pervasive.
Meanwhile, government revenues continue to suffer as the formal sector’s turnover took a massive plunge in recent quarters. PAKT paid over Rs84 billion to the government on account of excise duties and sales tax in CY16, a growth of 3 percent year-on-year. In 1HCY17, the firm’s business generated Rs32.2 billion on account of those two levies – a 40 percent decline – or Rs21 billion lower – year-on-year.
The firm’s profit margins naturally took a hit as top line receded in the half-yearly period. If the top line decline is the new normal, then some operational efficiency is in order. During the period under review, the cost of sales consumed 236 basis-points more of the gross turnover compared to 1HCY16. Top line exhaustion on the combined account of selling expenses and administrative expenses crept up by 196 bps compared to the year-ago period.
But cost savings will not matter much for the bottom-line going forward; such is the sharp decline in turnover. There is some silver lining for the top line; however, thanks to the fiscal measures announced in the FY18 budget, formal tobacco players may fare somewhat better in 2HCY17 and beyond. The industry now has a three-tier FED regime instead of two.
The finance ministry, perhaps feeling concerned over the tobacco tax loss, chose against raising FED on the top two slabs. From July 1 onwards, cigarette packs retailing above Rs90 a pack are carrying an FED of Rs74. Smokes selling between Rs90 and Rs58.5 a pack carry an FED of Rs33.4. The introduction of a bottom slab – where cigarettes selling below Rs58.5 a pack would have an FED of Rs16 per pack – may help the formal players fight the cheaper DNP brands in the affordable segment.
The 3QCY17 results would show whether those measures are helping the industry and government fortunes. For now, PAKT must take steps to become a leaner organisation. But still, that wouldn’t answer the critical question of how to become price-competitive in this market. Are price discounts really the answer?
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